Earn-out

An earn-out arises where buyer and seller agree about the past but not about the future. The seller believes the plan is achievable; the buyer does not. Rather than splitting the difference on price, part of it is made contingent: if the plan materialises, the balance is paid.

The measure is the real negotiation

EBITDA is the most common basis because it comes closest to earnings. That is also what makes it the easiest to influence: group cost allocations, a change in accounting, additional investment in sales or a different cost key can depress the figure without anything changing in the business. Revenue is harder to manipulate but does not reflect earning power. Operational milestones – an approval, a customer win, a migration – are unambiguous but rarely representative.

Whatever is chosen, the metric has to be defined arithmetically in the contract, with accounting rules, cut-off conventions and a list of what may not be charged against it. An earn-out on an undefined EBITDA is an invitation to litigate.

The protective clauses that belong with it

• management rights for the seller during the earn-out period, or at least veto rights over material interventions
• a ban on group cost allocations and transfer prices that reduce the measure
• separate accounting for the acquired business if it is integrated
• inspection and audit rights over the calculation, and an expert determination where the parties disagree
• provisions for an onward sale, a change of control and termination of the seller

What happens in practice

Earn-outs rarely fail because of the business and often because of attribution. After integration it is frequently no longer possible to establish which revenue belongs to the acquired business. Anyone agreeing an earn-out has to secure the necessary accounting from day one – separate cost centres, separate revenue accounts, documented allocation keys. That is a task for the finance function, not the legal department, and it sits inside the wider post-merger integration.

Accounting and tax

For the buyer an earn-out forms part of the cost of acquisition and is, depending on the accounting framework, recognised at fair value and remeasured. For the seller the inflow generally arises only on payment. Both belong on the table before signature, because the after-tax picture can differ considerably from the headline figure.

How earn-out, the working capital adjustment and net debt combine into the amount that actually moves is set out under locked box and closing accounts.